The CBOE Futures Exchange (CFE) and DRW Trading Group have completed an agreement that will allow CFE to use DRW's patent-pending methodology to create variance futures that match the quoting conventions and economic performance of over-the-counter (OTC) stock index variance swaps.

CFE plans to introduce a new futures contract based on the variance of the S&P 500 (SPX) later this year, subject to regulatory approval.

Variance swaps measure the difference between the expected and actual variance of an underlying instrument over a fixed time period. Currently, variance swaps on the S&P 500 index are estimated to trade USD10 million vega notional per day in the OTC market. Vega is the dollar exposure to changes in volatility. "We are thrilled to work with DRW to create a variance futures offering for OTC users and for traders who traditionally have not participated in the OTC variance swap market," says CBOE President and COO Edward T Tilly (pictured). "CFE's ability to offer products that combine the conventions of OTC variance swaps with the benefits of exchange-traded futures – transparency, price discovery, certainty of execution and protection against counterparty risk through the OCC – will offer significant benefits for both groups."

"As a firm with a strong presence in both exchange and OTC markets, we envision both sides benefiting from cleared variance futures," says Donald R Wilson, founder and CEO of DRW Trading Group. "Access to variance swaps has typically been limited to the large OTC broker-dealers. By creating an economically equivalent futures-style contract, more market participants will have another avenue to mitigate volatility risk exposure. In addition, with more players in the market, both groups can benefit from an increase in market liquidity."